The surprise decision by the PBoC to raise rates by 25bps (I’d now expect tomorrow's GDP and CPI numbers to be upside surprises !) led to de-risking across the board and US stocks suffered their biggest setback in 2 months. The dollar (the $ index DXY +1.7 percent) was the main beneficiary as it had its biggest gain in 6 months. Commodities had a knee-jerk move lower with Gold -2.5 percent, Crude -4 percent, and Copper -3 percent. Every major S&P Subsector finished in the red with Autos (-3.3 percent), Energy (-2.4 percent), and Materials (-2.25 percent) the biggest losers. Financials (-.9 percent) held up very well over the morning, but a report released at 1:30 rattled the Banks and sent the S&P’s down an additional percent (1156 low). The New York Fed and Pimco are looking to force BAC (-5 percent) to buy back up to $47 billion worth of mortgage bonds originated by its Countrywide division which they failed to service properly. While the ultimate cost remains unknown, a decision against Bank of America (BAC) would set precedent and could hit JPMorgan (JPM) (-1.5 percent) and Wells Fargo (WFC) (-1.3 percent). In a sentence, by breaking the law on foreclosures, and by calling a temporary moratorium on them, BoA may have failed in its duty as manager of derivative CLO structures which contain these mortgages (often leveraged). If so, buyers of these products could have the right to PUT (i.e. sell them back) to BoA. After the close, Yahoo posted a disappointing earnings outlook, further evidence of the search engine’s struggle to keep up with Google.
Today’s Market Moving Stories
- Stocks on the move in Europe today include Novo Nordisk, the world’s biggest insulin maker, which is up a healthy 7.4 percent on news that the U.S. Food and Drug Administration yesterday said that Amylin Pharmaceuticals Inc. (AMLN), Eli Lilly & Co. (LLY) and Alkermes Inc. (ALKS) must conduct a new study of their drug, delaying its debut by as much as 20 months for their rival drugs.
- After Tuesday’s sell off Rio Tinto Group (RTP) has bounced back 1.8 percent after he world’s third-largest mining company said it will spend $3.1 billion increasing the capacity of its iron ore infrastructure in the Pilbara region of Western Australia to 283 metric million tons by 2013. Rio made the announcement two days after abandoning a joint venture with BHP Billiton (BHP) to combine their Pilbara operations to save $10 billion.
- Heidelberger Druckmaschinen climbed 5.9 percent as the world’s largest maker of printing presses said second-quarter sales rose to €633 million from €499 million . The operating loss narrowed to €5 million to €10 million.
- Faurecia sank 5.8 percent as Europe’s largest maker of car interiors said One Equity Partners, a unit of JPMorgan, sold a 13 percent stake in the French company in a share placement at €18.20 a piece.
- In London BG, a U.K. gas explorer, fell 1.8 percent on news that the Australian government may delay approvals for proposed coal-bed methane projects in Queensland after Origin Energy Ltd. Said it found traces of banned chemicals in exploration wells, Macquarie Group said.
BG had said this month it was “confident” that Australian Environment Minister Tony Burke would stick to his deadline and decide by Oct. 22 whether to approve the British company’s proposed Queensland natural-gas project.
- Stryker (SYK) is up 6 percent in Europe after the maker of artificial body parts and hospital equipment said it expects to earn between $3.27 and $3.30 a share in 2010. Analysts, on average, had estimated profit of $3.26, according to a Bloomberg survey. The company had previously given a forecast of $3.20 to $3.30 a share.
- But Hansens Transmissions collapsed 19 percent after the maker of products used in wind generators and cooling towers said revenue for the 2011 fiscal year will fall about 10 percent from 2010. The company previously expected revenue to grow between 5 percent and 10 percent it said. The sectors largest player, Vestas Wind Systems is down 3.5 percent in sympathy.
- Stobart Group has dropped 8.3 percent after the U.K. trucking company reduced a full-year profit forecast. A reduced spending by Network Rail and increased overall finance costs will affect profit, the Warrington, England-based company said today in a statement.
- BoA: The Foreclosure mess shows no signs of abating.
- Lots going on here. Overnight news cast a shadow on Tuesday’s BoA’s results, as MBS bondholders are ganging up to potentially force repurchase by BoA. Q3 results yesterday were on balance, decent, although repurchase issue definitely has a long way to play out.
- However, headline risk will dominate spreads in the near term for BoA (and other US mortgage players) and Q3 results yesterday are largely redundant in the face of stories emerging that a group of bondholders including Pimco, Blackrock, the Fed, MetLife, WAMCO and others are potentially looking to force BoA to repurchase up to $47 billion of mortgages (Countrywide legacy packaged bonds) citing “alleged failures to service the loans properly”. This is total deal size, but the bondholders that have grouped together are said to represent “not less than 25 percent” of that number. The letter lists a number of failures on the part of Countrywide mostly relating to a failure on its part to report when loans have breached the Reps and Warranties. The mortgage pools are said to be about 50 percent delinquent. Our ABS analyst in the States indicated that if BoA buy back pretty much all the delinquent loans and take a 40 percent loss on each one, you can see what the worst case scenario looks like. However, we know anything involving lawyers will take a long time to unfold. BoA has said it will “vigorously defend itself” but there is a good chance that BoA could relook this stance and sit down and negotiate with holders if that gathers more traction.
- Yesterday we saw that BoA only built reserve by a small USD465m for repurchases of mortgages. This could be lumpy going forward, inconsistent. BoA have not so far estimated potential realised losses on private label investor repurchase claims, which leaves scope for future negative surprise in quarterly earnings if this provision figure spikes.
- US: Atlanta Fed President Dennis Lockhart’s said “If we’re going to pursue another round of quantitative easing, it has to be a large enough number to make a difference … as a monthly number, ($ 100 billion) is fairly consistent with what we did before, and so I think it would certainly be in the range of numbers one might consider … but if you were talking about $100 billion as simply the overall program, I think that’s too small”.
- Dallas Fed President Richard Fisher said “The outcome of the next [Federal Open Market Committee meeting] is yet to be determined”. He added “you should bear this in mind given the recent speculation about the prospect for further quantitative easing or the shape and nature of forward policy guidance: no decisions have been made on these fronts and will not be made until the committee concludes its deliberations at its next meeting on November 3rd”.
- New York Fed chief William Dudley said “Viewed through the lens of the Federal Reserve’s dual mandate – the pursuit of the highest level of employment consistent with price stability, the current situation is wholly unsatisfactory.”
- Minneapolis Fed, Narayana Kocherlakota said “My own guess is that further uses of QE would have a more muted effect on Treasury term premia.”
- Fed Governor Elizabeth Duke states that the outcome of the next FOMC meeting is not a done deal and that “A lot of things can change between now and the meeting.”
- UK: Chief Secretary to the Treasury, Danny Alexander, inadvertently reveals the expected scale of impending job losses (from a copy of the Comprehensive Spending Review) at 490,000 by 2014-2015.
Markets steady after China Hike.
And why wouldn’t they steady? This is exactly the same reaction we had to the 3-4 hikes to the reserve ratio requirement that we had earlier this year. Risk sells off for 24 hours, then rebounds as soon as it becomes clear that the sky is not falling in. Ok, granted, a policy rate hike is a more extreme form of tightening than an RRR hike, but it’s still just a form of tightening. The market needs to get used to policy rate adjustments – I think we’ll get 3 more of these in 2011. The impact was exaggerated by the fact that:
- We haven’t had one of these particular rate hikes in 3 yrs (how many market participants do you reckon have never seen one?)
- It took the market by surprise – the RRR was only hiked last week for the biggest banks, so no one was expecting this to come so soon.
- Everyone already long risk and v short USD – a there was an unsightly scurry to close short USD positions
So all eyes were on the Shanghai open to gauge fallout. Opened down -1.8 percent. But recovered in minutes. Now +0.7 percent.
So I’d expect the risk-on trade to re-stablish itself and for all of this to be forgotten in a day or two. And the focus will shift to a major batch of China data due tomorrow: GDP, CPI, retail sales, IP. Yesterday’s hike does suggest that these figures will be strong, which should be another excuse to buy risk (although be wary if CPI prints very high).
One For The FX Conspiracy Theorists
Since late last week rumours have been circulating of a possible accord between the US and China ahead of the G20 meeting (something that is needed if the situation in financial markets is not to take a turn for the worse). I must say that I’ve expressed scepticism about this but lets looks at the evidence. The first signpost that this might be something more than mere speculation came late on Friday with the news that The Treasury Department had, conveniently, delayed the currency manipulation report until after the U.S. congressional elections on November 2nd in order to “take advantage” of the G20 summit in South Korea on November 11th and the APEC forum a few days later. It was also noticeable that the Treasury’s statement sounded a surprisingly positive note about Chinese currency policy, stating: “Since September 2, 2010, the pace of appreciation has accelerated to a rate of more than 1 percent per month. If sustained over time, this would help correct what the IMF (International Monetary Fund) has concluded is a significantly undervalued currency.” This sounded like a conscious attempt to lay the groundwork for not calling China a currency manipulator.
If the first part of any accord would certainly require the US not to call China a currency manipulator and to show greater support for its own currency (aside from Secretary Geithner’s comments, talk has resurfaced that the Fed will take a more incremental approach to quantitative easing – a story that first emerged in the WSJ is late September) then what would China need to show in return? Simply put, it would be a signal that it was prepared to allow the CNY to move at a faster pace. One possible way of doing this could be to show a greater willingness to focus with inflationary pressures and less on attempting to keep the CNY competitive.Given that a rate hike should, in addition to tackling inflation directly, make the currency rather more attractive (although we do note that the CNY came under some downward pressure at the open today before recovering) it could be argued that yesterday’s move was just such a signal.
All of this is highly speculative. However, the timing of this week’s comments and policy shifts (following the announcement of the delay of the currency manipulation report and ahead of G20) at least allows the possibility that some agreement has been reached. Even the timing of yesterday’s move by the PBOC seemed significant (just ahead of the NY open) given that the norm up until December 2007 was (if I remember it correctly) that rate hikes were revealed on Fridays after the stock markets had closed or during weekends. If some kind of accord has been reached then this would be hugely significant, signalling trend reversals in a wide range of markets (we note that EUR/USD is already sending just such a message).
The minutes to October’s meeting of the BoE’s Monetary Policy Committee (MPC) provide further confirmation that the Committee is moving closer to recommencing quantitative easing. As expected, Adam Posen broke ranks with the majority of the Committee in voting for an extra £50bn worth of quantitative easing (QE), while Andrew Sentance was again alone in voting for a 25bps hike in the Bank Rate. However, the minutes revealed that for some remaining members “the likelihood that further monetary stimulus would become necessary in order to meet the inflation target in the medium term had increased in recent months.” I continue to think that the fading recovery will persuade the remaining members to sanction more QE, perhaps early next year.
Company / Equity News
- J&J (JNJ), which owns 18.4 percent of Elan (ELN), is co-responsible, with Pfizer (PFE), for the clinical and potential commercial development of Bapineuzumab; and is rolling out Invega Sustenna, which incorporates Elan’s drug delivery technology, issued a steady set of Q310 results yesterday. The company reported a 2.5 percent increase in EPS to $1.23 (well ahead of consensus – $1.15) from a 0.7 percent decrease in revenue to $15.0bn ($15.2bn expected). The company increased full year earnings guidance, but as a result of FX movements rather than operational performance. Of direct relevance to Elan, the company noted that there was strong growth in a number of newly launched products, including Invega Sustenna. Management noted that although the overall Invega franchise only grew 1.0 percent as reported (2.7 percent in local currencies) to $98m, the drug was gaining physician and patient acceptance. In prepared remarks on the pipeline, Bapi was flagged as a key asset with “tremendous potential”. The two US arms of the Phase III trials are now fully enrolled (biomarker studies otwithstanding), with a possible FDA filing pencilled in for the 2012/2013 time period, as previously stated.
- Retail Group has reported first half results this morning. Pre-tax profit declined by 23 percent to £94.7m slightly ahead of expectations of £94m. Revenue declined by 3 percent to £2,270m with like for like sales down 6.5 percent at Argos and 0.8 percent at Homebase. The company has continued to focus on reduced costs with operating costs falling by £39m or 4 percent to £947m. The company maintained its dividend at 4.7p. The group had a closing net cash position of £327m and repurchased £109m of its own shares during the quarter. Home Retail pointed out that the outlook remains difficult however it does not expect things to get ‘much’ worse. Given Home Retail’s strength of balance sheet we see it as being able to weather the current difficult economic climates in both the UK and Ireland. But Tesco remains the preferred play however due to its lower cost product offering, international diversification in particular from emerging markets and the potential catalyst of the expansion of Tesco Bank over the coming years.
- German chemical giant BASF (OTCQX:BASFY) pre-released Q3 10 results that were well ahead of expectations. Q3 10 Sales rose 23 percent YoY to €15.8 billion (€15 billion consensus) with EBIT €2.15 billion well ahead of the €1.8 billion expected. BASF raised its FY10 outlook to EBIT of “over €8 billion”, versus current consensus of €7.3 billion. As usual, the company’s outlook for the longer term sounds a cautious tone given macroeconomic uncertainties. Given management’s appetite for chunky acquisitions, and likely focus on shareholder returns, we wouldn’t expect spreads to outperform from current levels.
- Peugeot (OTCQX:PEUGY) has raised FY10 earnings guidance after Q3 10 revenues of €13 billion came in strongly ahead of consensus (€12.3 billion). Their revised FY10 guidance of “more than” €1.5 billion Adjusted EBIT is in line with current expectations, as is their upgrade to their forecast of a 5 percent fall in FY10 European auto sales. Given that PSA earned €1.2 billion Adj EBIT in H1, the outlook remains relatively subdued as European markets struggle to gain positive momentum again post-scrappage incentives. Despite the weaker implied second half to the year, credit fundamentals have stabilised – PSA expects flat net debt through year end implying net leverage of about 0.7x. Looks a far better bet than Renault (GM:RNSDF).